Germany’s Borrowing Costs Edge Higher

The after-effects of last week’s suggestion by the European Central Bank that it may step in to support troubled pockets of the euro zone’s bond market continued to reverberate Wednesday, as the more positive market tone pushed Germany to pay slightly higher yields at a debt auction.

As the region’s debt crisis has deteriorated in recent weeks, nervous investors have flocked to the perceived safety of German government bonds, shoving borrowing costs for this country–the euro area’s economic powerhouse–to record lows.

But less than a week after ECB President Mario Draghi boosted Spanish and Italian government bonds with a suggestion that the central bank is willing to revive purchases of this type of debt, Germany’s 10-year borrowing costs nudged higher at auction, reflecting greater confidence that the long-running debt crisis is easing.

At Wednesday’s auction, Germany sold €3.4 billion euros ($4.218 billion) of the 1.75% July 2022 bund, its current 10-year benchmark, at an average yield of 1.42%. Germany raised 10-year money at a record low rate of 1.31% at the July auction.

The Finance Agency’s €4 billion auction attracted €6.262 billion in bids. The Bundesbank, which conducts German federal debt sales, retained 15% of the offer size, the lowest at a 10-year Bund auction in the year to date, reflecting strong broader demand at the auction.

“The mantra of ‘never selling’ the Bund is still very strong,” said Jens Peter Sorensen, chief analyst at Danske Markets, adding that demand for safe assets even at these depressed yields is very strong.

In another sign of a well-received auction, the average and minimum accepted prices matched at 103.03, thus the auction had no so-called “tail”.

“Demand for the 10-year German bund auction has been difficult to predict in August as other major [euro-zone]countries don’t hold their long coupon auctions and liquidity conditions are thin,” said Annalisa Piazza, economist at brokerage Newedge. “This time around, dealers might have been a touch more present as market conditions are very different from the past summers, when trading activity was less intense,” Ms. Piazza added.

This bund auction represented this week’s only scheduled bond sale in the euro zone as issuance traditionally slows down sharply in August.

The German Finance Agency will launch a new series of 10-year Bund in September.

Analysts at Citigroup as well as AXA Investment Managers said they think the small rise in German yields is likely to be temporary, with falls possible later as the single currency area’s debt crisis is far from over.

“Despite the higher yields and the current price action, we retain a bias for [buying German government bonds] over the medium term,” Citigroup’s analysts said in a note. “The ECB looks set to ease policy further… and the fundamentals of the [euro-zone] crisis remain unresolved,” they added.

Fund managers at AXA Investment Managers said they don’t expect a significant increase in yields of German government bonds, and expect them to continue hovering at low levels and within a narrow range.

“The very low short-term yields and the lasting recession in the euro zone will hamper an increase,” they said. “However, [Bunds] continue to be an important instrument for the safety of a portfolio,” they said.